Will Amazon manage to hit high earnings expectations?

Investors have previously punished Amazon for missing profit expectations. There are concerns it could happen again as the market’s first-quarter earnings expectations are high.

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2016-04-13T17:10:59+0100

Amazon is set to report another jump in revenue when it reports first-quarter results on 20 April, but the company could again struggle to meet profit expectations amid stiff competition for its web services and rising costs for online retailing.

The internet retailing giant has consistently outperformed revenue expectations in recent quarters, but has also missed profitability expectations several times in the past and has been punished by investors for these misses.

Consensus earnings expectations proved to be too high when Amazon reported its fourth-quarter results, and reported earnings per share (EPS) came in 34% below market expectations. A number of analysts lowered their long-term price targets for the stock in the wake of the fourth-quarter release, but expectations are still quite high for the first quarter. Adjusted EPS is expected to come in at $1.618 and revenue is expected to grow to $27.953 billion, from $22.717 billion a year ago.

Investors are keenly focussed on slowing margin growth in the Amazon Web Services, its cloud computing services business that’s facing increased competition from the likes of Microsoft and Google, as well as rising costs in Amazon’s online retailing business.

Where are margins heading? Amazon has a wide global distribution and bills in US dollars so these are less subject to currency volatility, but its costs are denominated in the local currency. The strength of the dollar in 2014 and 2015 meant costs in local currency terms were lower, helping margins. But this trend has reversed in 2016, and that’s likely to weigh on margin growth in the first quarter.

Despite this, Amazon’s gross margin is expected to grow to 34 % in the first quarter, from 31.9% in the fourth quarter, which is asking a lot now that forex has become a headwind.

Amazon stock hit a recent high of $696.44 on 29 December, but then declined 31% to $474 on 9 February. The fourth-quarter profit miss on 28 January didn’t help, but a lot of the decline was driven by issues surrounding Amazon’s onerous contract stipulations with suppliers that forced suppliers to pay for free shipping of items on their own. Some have argued that these issues have now been fully priced into the stock.

The big fall in the share price has likely made investors more cautious on the stock, and the key concerns are growing shipping costs in the online retailer side of the business and increased competition set to slow margin growth in the Amazon Web Services business. Amazon also has a history of re-investing retained capital to meet competition head on, which has often reversed its margin growth trajectory.

The Amazon stock price chart since the beginning of August is interesting, particularly looking at the three occasions when the stock has dropped below $500. It hasn’t stayed below $500 for long, and on two occasions a strong rally has followed, indicating some very strong support around that level.

However, the stock has recovered considerably since February and is now trading around $600. The key level to watch around earnings is the 61.8% retracement level from its late-December highs. An upward break through that level would be a strong technical indicator the stock could push back up to $700. But looking at the historical stock price reaction to even minor earnings misses, the risk reward around the results announcement does look biased to the downside, particularly given Amazon’s still very high valuation levels.